U.S. LNG In Central and Eastern Europe – Taking Diversification Seriously

Last week President Trump met in Warsaw with Polish officials and Central and Eastern European (CEE) leaders at the Three Seas Initiative Summit. The event brought together countries from the Adriatic, Black and Baltic seas to discuss development of regional infrastructure necessary to reduce their energy dependence on Russia and ensure energy security. This happened shortly after the first cargo of U.S. LNG, carried by the 162,000 cbm-capacity “Clean Ocean, entered the Polish port of Swinoujscie. Both the U.S. and Polish governments lauded the cargo and, following the meeting with Donald Trump in Warsaw, Polish President, Andrzej Duda declared a possibility of signing a long-term agreement (LTA) for the supply of U.S. LNG into Poland.

Much of Duda’s statement is political rhetoric given that LTAs are not signed between governments. Instead these contracts are commercial decisions made by individual companies. But the strong rhetoric coming from both governments in support for U.S. LNG exports to CEE is an indicator that beyond economic aspect, this trade has strong geopolitical dimension.

Given competitiveness of Russian gas and willingness of Gazprom to defend its market, it is highly unlikely that U.S. LNG imports would grant CEE (or Europe as a whole) full and unconditional natural gas independence from Russia. However, standing ability to deliver U.S. (or other non-Russian) gas to Europe provides “credible threat” and changes the bargaining positions of all parties involved. In such scenario Russia stands to lose not as much market share as geopolitical influence that it has derived from CEE’s dependence on its gas. And while LNG exports will not give the U.S. more geopolitical power in Europe per se (given the increasingly competitive global LNG market), Russia’s loss in this regard is a strategic gain for the U.S.

But can the U.S. and CEE governments truly affect the outcome of essentially commercial transactions? Can they effectively facilitate the ‘credible threat’ of U.S. LNG exports? And if so, how?

This ability depends on several factors. These include the usual: pricing and, given competitiveness of Russian gas, the willingness of the CEE governments to support a security premium on natural gas from a non-Russian supplier. Also, policy makers should pay close attention to current policy decisions within the EU that relate to infrastructure and antitrust law, as these decisions may not only impact profitability but also feasibility of LNG imports well into the future.

Forces that Influence Europe’s Natural Gas Market

The European market, while not expected to be as robust as Asia over the coming years, will remain an important source of demand for natural gas suppliers. As reported by Eurogas, going forward Europe will need to import much more natural gas than suggested by demand growth alone (Figure 1). In addition, the region is attractive given dependability of the market and reliability of European governments and customers.

Figure 1. EU Natural Gas Demand through 2030.
Source: Eurogas, “Natural Gas Demand and Supply: Long term Outlook to 2030.”

Much of the future makeup of European natural gas supply might be determined not only by market forces but also by geopolitical considerations and European Union legal and antitrust decisions.

The two main decisions currently on the agenda that will have broad and direct consequences for LNG trade in Europe are: 1) permitting of the Nord Stream 2 pipeline to carry Russian gas under the Baltic Sea directly to Germany, and 2) antitrust decisions by the European Commission related to Gazprom abusing its monopoly position in the CEE.

European Diversification and What It Means to Different Parties

Natural gas market diversification has become a hot topic in Europe following several breaks in Russian gas deliveries between 2005 and 2009. The 2014 crisis in Ukraine and complete shut off of natural gas supply flowing from Russia added urgency to the matter. In principle, all EU members agree that diversification is needed. But there is a visible rift between how diversification efforts are envisaged by the West versus the CEE countries.

Ukraine, Poland, and the Baltics in particular are pushing for diversification away from Russia. Their efforts include a buildup of LNG infrastructure, with the already functioning LNG terminal in Lithuania and the aforementioned LNG terminal in Swinoujscie. Plans are drawn already to expand the existing terminals, and new LNG terminals are planned in Estonia. Small-scale LNG projects are also in the works in the Baltics. In addition, the region is considering facilities for regasification, storage, rebunkering, and reloading, as well as investment in rail transport to support future LNG imports.

It goes without saying that such imports will never be realized unless the price of LNG is competitive. But it is worth noting that although the price of LNG brought to Swinoujscie by U.S.-based Cheniere Energy has not been disclosed, it was lower than Russian and German EEX natural gas prices, according to the Polish trader, PGNIG.

In addition, many CEE countries may be willing to pay a certain security premium for LNG to sustain diversification efforts away from Russian natural gas. Regardless their willingness to pay such a premium rate, these countries also actively seek non-LNG market opportunities to diversify supply, including onshore projects like the Baltic pipe. This means that the ability to pay excessive prices by those countries may be moderated in the future, as the CEE gas market becomes more competitive.

The strong push toward diversification within CEE is related to two main factors. First, dependency rates on Russian natural gas have been historically very high, with some CEE countries previously entirely dependent on Russian imports (Figure 2 below). This led to uncertainty in terms of reliable gas supplies and higher prices. If non-Russian supplies of natural gas are readily available, Gazprom loses ability to charge monopoly prices. Second, there is a strong sentiment that Russia is ready and willing to use energy dependence to achieve political goals regarding its relations with CEE countries. Much of this feeling is informed by the Soviet past, but some of the uneasiness stems from more current events, including Russian invasion of Ukraine in 2014 and annexation of Crimea. Particularly, Poland and the Baltics see LNG imports as a way to dilute the Putin Regime’s economic influence over their countries and to parry Russian attempts at undermining the democratic process and social unity.

Figure 2. Europe’s Dependency on Russian Gas, 2014.
Data Source: Eurogas, Statistical Report 2015.

 

On the other hand, Western European countries are generally content with diversifying natural gas supply routes away from Ukraine that they see as a high-risk transit territory. They are less interested in diversifying supplies away from Russia and are focused rather on lowering cost than on geopolitical implications of dependence on Russian natural gas. This is related to lower dependency rates in that region (Figure 2) and to long-standing collaboration between Western Europe’s utilities and Gazprom that is seen as reliable partner and supplier. There is much less concern about possible monopolization of the European gas market by Russia and its geopolitical implications.

Nord Stream 2, EU Antitrust Decisions & “Credible Threat” of U.S. LNG Imports

Whether CEE countries will be able to achieve their goal of natural gas market diversification and whether U.S. and other LNG producers will have access to the European market will depend as much on price as on other factors. When it comes to price Russia has significant and undisputed advantage. But EU’s policy framework, infrastructure buildup and willingness of countries to support non-Russian supplies will define boundaries within which market forces operate. As such, these factors will determine whether Russian gas dominance in Europe (particularly in CEE) will be strictly commercial or whether it will continue to yield geopolitical power. Construction of Nord Stream 2 and EU antitrust decisions are currently the two decisions that will have a bearing in this regard and where government’s, and not companies, can influence the outcomes.

Nord Stream 2 (NS2) is planned to cross directly from Russia to Germany. The new pipeline is supposed to accompany the already existing Nord Stream 1, reducing the need for the Ukrainian transit route. The plan is constituent with Western Europe’s efforts to diversify natural gas routes away from the risky transit territory. CEE countries argue against the pipeline, which in their view would damage their efforts geared toward diversity of supply and reducing dependence on Russian gas. If recent research is correct, these fears may be well substantiated. The research shows that NS2 would allow Gazprom to pre-empt diversification measures by using the entire capacity of current pipeline infrastructure. With pipelines committed to Russian gas, Gazprom could deter other potential sources of supply from entering the market and keep prices in CEE countries high.

Gazprom current commitments in the Directorate-General for Competition (DG COMP) antitrust investigation may have similar consequences. Considered soft, regarding the time and scale of alleged anticompetitive practices that affected trade in the CEE, they would possibly result in eliminating competition from other sources of natural gas supply (though, as opposed to NS2 they do not seem to increase prices of natural gas in the CEE or elsewhere in Europe). And while these commitments may be changed in the course of further proceedings, a soft response from the EU indicates general tendency and provides a precedent for future decisions.

EU decisions on NS2 and antitrust will have a profound impact on creating favorable conditions for U.S. LNG in European markets and whether it will be able to provide the ‘credible threat’ to Russian natural gas dominance. Poland and the Baltics are pushing hard against NS2 in an effort to advance their diversification efforts. The U.S. government is also acutely aware of the problem and has engaged in anti-NS2 sanctions and anti-NS2 diplomacy in the region. But there is a noticeable lack of involvement from other CEE countries. Thanks to recent infrastructure and regional cooperation agreements these countries feel more secure when it comes to natural gas deliveries not realizing the potential negative effects NS2 may have, once completed.

This lack of engagement, together with Western Europe’s limited view of diversification may well be responsible for Russia regaining its position as Europe’s dominant natural gas supplier, a position that has been seemingly slipping away from Russia in recent years as LNG technology took off (Figure 3). This is critical especially now as the European Commission (EC) seeks member-state approval to negotiate with Russia on NS2 with an intent to extent at least main provisions of the EU natural gas legal framework (Third Party Access, unbundling) onto NS2.

Figure 3. Origin of Primary Energy Imports to the EU (% Non-EU Imports).
Source: Eurostat

 

Is There a Hope for U.S. LNG Exports to Europe?

The first U.S. LNG cargo to Poland is a result of a one-off transaction between Chenier and a newly established Polish trading office in London. Although it is probable that future LNG deals will be concluded later this year, the problem of the long-term profitability of U.S. exports of this commodity to the EU is still open. Governments have little say as to what contracts are signed but they have the power to affect market conditions within which companies operate. Currently, NS2 and to a smaller extent, EU antitrust decisions are factors, which governments should consider if they want to affect future access to Europe’s natural gas market.

When it comes to the U.S., its government has been active in supporting European energy diversity in many ways, including active opposition to the NS2 pipeline via unilateral U.S. sanctions against Russia and diplomatic assurances in the Baltics and Poland. But this may not be enough. There also may be a value in the U.S. focusing on issue diplomacy in those European (CEE and non-CEE) countries that are currently quiet or in support of NS2 but would ultimately lose if NS2 comes to be.

That being said any success of CEE and U.S. efforts does not guarantee unobstructed flow of U.S. (or any other) LNG to the European market. However, ability to access that market by any non-Russian supplier will provide an effective check on both, Russia’s pricing policy and the influence that country has historically derived from its monopoly over the CEE market.

This article was originally published on Forbes.com and can be viewed here.

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Azerbaijan: Where Geopolitics Perpetually Trumps Democratization

If you take just a little a glimpse at the June 12th Opening Ceremony of the inaugural European Games held in Baku, Azerbaijan, you will see it right away: Azerbaijanis know how to throw a great party; it is simply in their DNA. Not only that, the elegance and depth by which traditional elements of Azerbaijani culture were expressed via contemporary media during the event, are a testimony to a beautiful and grand nation—a nation that lies at the crossroads between East and West and that has taken upon itself the challenge of modernization, and has done this with great success since gaining its independence from Soviet rule in 1991.

In light of the European Games and the growing ties between Azerbaijan and the West, this blog first looks at the factors demonstrating the authoritarian nature of the current Azerbaijani regime. It then tries to identify causes for this political stalemate, highlighting the impact of Azerbaijan’s geostrategic location on domestic political developments.  It then moves on to discuss how Azerbaijan uses its strategic importance to undermine discussions on the state of human rights and democracy at home and within international institutions. Finally, it looks at possible implications for Western democracy promotion efforts in Azerbaijan.

Azerbaijan at the crossroads

MODERNIZATION WITHOUT DEMOCRATIZATION

Unfortunately, although the country has modernized, this did not go hand in hand with democratization. In fact, Freedom House’s latest 2015 Nations in Transit report places Azerbaijan within the category of consolidated authoritarian regimes with an overall democracy score of 6.75 (compared to 6.68 in 2014), a score of 7 being farthest away from democratic progress.

There are a few reasons that explain this regression. A single family has run Azerbaijan continuously almost since independence. Heydar Aliyev, President of Azerbaijan from 1993 to 2003, then passed the torch of authoritarian rule—not the Olympic one—on to his son, Ilham. The younger Aliyev has been in power ever since. While he should not still be in office under the terms of the Azeri constitution, which once limited the presidency to two five-year terms, it was made possible by an amendment in 2009—a popular move among authoritarian leaders seeking to remain in power.

Furthermore, no election ever held in Azerbaijan since the country’s independence has been rated as free and fair by any credible electoral observer. Notably, the Organization for Security and Cooperation in Europe’s Office for Democratic Institutions and Human Rights (OSCE/ODIHR) has repeatedly pointed to serious issues both in the pre-electoral environment and the election process itself. Election rigging was especially showcased during the last presidential election in 2013, when the Azerbaijani Central Election Commission accidentally released election results via a smart phone application, declaring Ilham Aliyev winner, even before the voting had begun. Moreover, the country’s human rights and governance records are appalling: the list of political prisoners is awfully long for a country of only about 9 million inhabitants, and corruption permeates most spheres of society.

GEOGRAPHY: A CURSE FOR DEMOCRATIZATION

The ruling elite consistently crushes attempts by civil society to liberalize, if not democratize, Azerbaijan. What are the challenges that have been standing in the way of a popular democratic upheaval in Azerbaijan, especially given the fact that Azerbaijan does possess preconditions for democracy? In fact, the economy is booming, the society is literate, and college education is by far not an exception. The “Land of Fire” (the meaning of the word Azerbaijan) also has growing ties to the West with Azerbaijani students benefiting from exchange programs and studying abroad both in Europe and the United States, and increasing business relations connecting the country to Western partners. Finally, Azerbaijan is a member of the Eastern Partnership of the European Union, as well as NATO’s Partnership for Peace, the OSCE, and the Council of Europe. All of these institutions aim to actively support the advancement of democracy globally.

Three factors may explain the country’s failure or, more precisely, the local elite’s unwillingness to allow democratization in Azerbaijan.

Firstly, while linkages to democratic countries and institutions exist, linkages to authoritarian neighbors are just as extensive; notably to Russia, which may provide inspiration to Azerbaijani rulers.

Secondly, the ongoing conflict with Armenia over Nagorno-Karabakh nurtures a very strong nationalistic sentiment in Azerbaijan. The governing elite can use this substantial threat to Azerbaijan’s security to cultivate a strong nationalistic bond and present itself as the sole guarantor of its citizens’ safety as well as the only legitimate defender of its territorial integrity. In that respect, the quest for internal stability and resolution of the conflict seemingly overshadows the one for democratic consolidation.

Thirdly, and more importantly for the purpose of this the argument made here, the country benefits from a pivotal geographical position at the crossroads between Central Asia and Europe. This geographical position has given Azerbaijan a growing comparative advantage in negotiations with Western entities as tensions have grown with Russia and the need to secure alternative access to hydrocarbon sources has dramatically increased. This strategic location seems to be hindering democracy: the Aliyev clan captures revenues from oil and gas resources, allowing it to reward those who abide by its rule and punish those who don’t. From the perspective of domestic democracy activists, this geographic location can certainly appear as a curse.

STRATEGIC RELEVANCE FOR EUROPE AND THE UNITED STATES

Azerbaijan is a key country in the East-West energy corridor and could become a major contributor to the network of pipelines comprising the proposed EU’s Southern Gas Corridor. In fact, Azerbaijan has been instrumental in developing the Trans-Anatolian Pipeline (TANAP). The construction of this 1,150 mile long project began in March of this year. This pipeline is scheduled to be connected to the Trans-Adriatic Pipeline (TAP) as early as 2018. At that point it will start bringing gas to Europe. According to recent reports:

“TANAP will carry some 16 billion cubic meters (bcm) of gas during its first phase, 10 bcm of which will go to Europe and 6 bcm to western Turkey. Plans call for TANAP to eventually carry some 31 bcm of gas [by 2026], which will require other countries to supply gas to the pipeline.”

“Requiring Other countries to supply gas to the pipeline” means that Azerbaijan will not only become a provider, but also more importantly it will become a future hub for energy transit from Central Asia to Europe (and maybe even Iraqi Kurdistan and Iran at some point), all the while circumventing the Russian Federation’s territory. It therefore plays a crucial role for European energy security.

Azerbaijan is also essential to the EU’s overall strategy towards Central Asia to which it is the gateway. In Central Asia, the EU faces both, enhanced Russian, and Chinese competition. If the EU is to remain Central Asia’s most important trading partner it will have to revisit its strategy in order to keep this position. Securing access to the Caspian Sea via Azerbaijan is instrumental in that respect. Baku has also proven to be a strategic partner to the U.S. by providing troops, overflight rights, and civilian reconstruction efforts to NATO’s mission in Afghanistan.

BLOCKING INTERNATIONAL HUMAN RIGHTS AND DEMOCRACY AGENDAS

It seems that by becoming a major strategic partner for the West, the Aliyev regime has enabled itself to set the rules of the game with at least three major international institutions: the OSCE, the EU, and the Council of Europe.

  1. When in discontent with the OSCE’s media freedom representative, Djuna Mijatovic, who said that “practically all independent media representatives and media NGOs in Azerbaijan have been purposefully persecuted under various, often unfounded and disturbing charges,” the Azerbaijani government plainly ordered the OSCE to close its Baku office. This radical move came only a week before the start of the European Games. Unfortunately, given the legal framework upon which the OSCE is built, the Organization seems to have little leverage on Azerbaijan in such a situation.
  1. Similarly, the European Union does not seem to have much leverage on Azerbaijan when it comes to human rights and democratization, but for other reasons. In fact, as argued above, the EU’s narrative towards Azerbaijan appears to be tied to geostrategic interests. Therefore, it comes as no surprise that the EU delegation to Azerbaijan doesn’t even hint to human rights issues and challenges to democratization when presenting the EU-funded support program in Azerbaijan. In addition, Azerbaijan is not necessarily keen on signing an Association Agreement with the EU that would starkly include human rights and democracy aspects, but would rather prefer a more tailor-made “strategic partnership and modernization pact” with the EU.
  1. The most striking illustration is provided by a forthcoming article in the Journal of Democracy entitled “Europe and Azerbaijan: The End of Shame” where Gerald Knaus, President and founding Chairman of The European Stability Initiative, points to Azerbaijan’s “successes” within the Council of Europe:

By capturing the Council of Europe, the Azerbaijani government managed to neutralize the core strategy of the international human-rights movement: ‘naming and shaming.’ [Azerbaijan] captured key concepts, and through its allies in the Council introduced its own ‘newspeak’ to the corridors of Strasbourg. Political prisoners and dissidents became “hooligans”; what is in fact a consolidating, unrepentant autocracy was now a ‘young democracy’; Azerbaijan’s stolen elections became ‘free and fair’ and ‘competently organised.’ With most prominent human-rights defenders in jail, Azerbaijan, as chair of the Council of Europe in 2014, hosted international conferences on ‘human rights education’ and ‘tolerance.’ (…) While torture returned to jails in Azerbaijan, an Azerbaijani became the president of the Council of Europe’s Committee for the Prevention of Torture.

Can European and U.S. governments silently watch these developments unfold?

IMPLICATIONS FOR WESTERN DEMOCRACY PROMOTION EFFORTS

Most certainly, authoritarian consolidation affects European and American democracy promotion efforts towards Azerbaijan. To the very least, Western governments have to consider whether or not democracy assistance constitutes a component of their foreign policy towards this country and, more generally, whether democracy assistance is an important tool to enhance Western nations’ security.

One approach, excluding democracy promotion from Western foreign policies, is explored by the German Institute for International and Security Affairs (SWP) in its articleThe Pan-European Order at the Crossroads: Three Principles for a New Beginning.” The authors argue that the OSCE’s third basket—tackling democratization and human rights—should be downsized and emphasis should be put on energy security aspects. The founding principle of such a new pan-European order should be the inviolability of territorial integrity supplemented with non-intervention in political affairs.  This would mean “tolerate all existing regimes in Europe based on the principle of reciprocity” and, furthermore, “would imply that state actors would be prohibited from interfering in the domestic affairs of a country against that country’s will.” Hence, if such a new pan-European order were to emerge within the OSCE region, the U.S. government would not be allowed to support democratization efforts in Azerbaijan, if the government there would not permit it. In other words, the Azerbaijani ruling elite would be the one deciding how U.S. taxpayers’ money would be spent on “democratization” efforts. U.S. taxpayers might not enjoy this perspective. Yet, this is, in fact, already happening on the ground.

The OSCE region

In her articleReforming the Democracy Bureaucracy,” Melinda Haring shows that democracy promotion efforts in countries such as Azerbaijan tend to fail because of bureaucratic miscalculations on the donor country’s side. In fact, when a field-based organization such as USAID comes into play it is “susceptible to strong-arm tactics by repressive regimes,” which is precisely what happened in Azerbaijan. In countries ranked as non-free by Freedom House, Haring argues that a field-based approach tends to be counter-productive because there is only so much an authoritarian regime will let an unfettered organization accomplish. For instance, from 2007 to 2011, USAID spent $5.6 million to enhance the effectiveness of the Azerbaijani parliament—a parliament that has never been freely elected and of which all deputies are members of or proxies to the ruling party. The irony Haring reveals is that, while the “U.S. government found serious fault in the 2010 parliamentary elections [it] then trained the winners. USAID even paid for a new website to make the illegitimate parliament more efficient.”

Haring also claims that USAID’s work with NGOs in Azerbaijan cannot be assertive nor realistic: “USAID’s $3.5 million civil society program in Azerbaijan, implemented by the National Democratic Institute, tried to reach the NGO sector but it was not assertive in the least bit. The program, in part, gave small grants to local NGOs that were intended to empower youth and women, two powerless constituencies in Azerbaijan.” When the authoritarian stalemate is too strong, foreign government agencies working on the ground have to abide to the dictator’s rule if they want to remain in existence. On the contrary, donor organizations without field organizations are less vulnerable to pressures coming from authoritarian governments and can consequently achieve more. In fact, the U.S government has not only been directly active in Azerbaijan through USAID but also indirectly by financing an independent grant-making approach, the National Endowment for Democracy (NED). Through NED, the U.S. government can support democratization efforts without experiencing pressures from the Azerbaijani government:

The NED has a flexible model that enables it to assist democrats directly in repressive or sensitive political environments where U.S. government support, even if channeled through intermediary institutions, would be diplomatically or politically unfeasible. For example, the NED funds independent print newspapers in Azerbaijan, a country with virtually no independent media and active surveillance of its citizens on the web. USAID would be unlikely to fund such an ‘aggressive’ project. The field-based model, especially the political party institutes, is too cautious in closed societies and too few dollars actually reach the field.

Haring suggests that a system of triage (By triage Haring means that resources should be allocated according to strict criteria of priorities. In fact, democracy promotion should occur in countries where democratization appears to be a feasible outcome), and a division of labor between USAID and NED ought to be implemented in order to render U.S. democracy promotion efforts abroad more efficient; depending on whether the host country is clearly transitioning towards democracy or not.

To conclude, the emphasis on geostrategic interests of Western foreign policies towards Azerbaijan is understandable. Applying the concept of triage to democracy promotion efforts is realistic, especially in times of economic constraints and given the authoritarian stalemates on the ground—i.e., in Azerbaijan. Nonetheless, in the long-run, not turning a blind-eye on nondemocratic developments and encouraging Azerbaijani civil society to develop and raise its voice might be necessary to ensure that Azerbaijan will be a lasting ally of Europe and the U.S. In fact, not despite, but because of geopolitics, achieving democratic consolidation should be a real possibility for Azerbaijanis who seek it.  It should be a goal they know is supported by not only their civil society counterparts in Europe and the U.S. but also by European and U.S. governments. The day may come when a democratic system emerges in Azerbaijan. If and when this happens, Europeans and Americans may not want to reproduce the hypocrisies of the past: supporting a dictator one day and praising his demise the next.

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Winds of Change: Comparative Energy Security Policies

The meltdown of three reactors at Japan’s Fukushima Dai-Ichi nuclear power plant, following the Tōhoku earthquake and tsunami on March 11, 2011 (3/11), was a terrible event.  But for some renewable energy advocates, it also created an opportunity.  There was an immediate revulsion toward nuclear power around the world.  Even in France where three-quarters of the country’s electricity comes from nuclear power, popular opinion unambiguously swung against its continued use.  Across the border, Germany abruptly declared that it would abandon nuclear power and hasten its transition to renewable energy sources such as wind and solar.

How countries change their reliance from one energy source to another is often a hotly debated issue.  Nuclear power was once heralded as a low-cost and environmentally-friendly energy source—a way to end the need for dirty coal and oil.  But after Three Mile Island’s partial meltdown in 1979 and Chernobyl’s catastrophic meltdown in 1986, nuclear power fell out of favor.  But by then, many countries, including Japan and Germany, had already integrated nuclear power as part of their national energy mix and change would entail costs.  But what those costs would be were uncertain.

Until the Fukushima Dai-Ichi meltdown, Japan operated 50 nuclear power plants, generating 30 percent of the country’s electricity.  In fact, in 2002 the Japanese government sought to increase the share of nuclear power in the country’s energy mix to 40 percent by 2017.  Similarly, Germany operated 17 nuclear power plants, providing almost 20 percent of the country’s electricity.   For years, conventional energy supporters and renewable energy advocates clashed over just how quickly and how painful a transition from nuclear power to renewable energy sources would be.  Conventional energy supporters warned of a major economic shock if such a transition was not done gradually.  Meanwhile, renewable energy advocates played down the potential for economic pain after a transition was made.

But after Japan’s 3/11 disaster, both sets of advocates were proven wrong (and right).  The warning from conventional energy supporters was disproved first.  Within two months, Japan shut down 33 nuclear power plants, and two years later only two remained in operation.  Meanwhile, in Germany, eight nuclear power plants that were offline for testing or repair were kept shuddered.  A combination of increased use of coal-fired power plants and renewable energy sources and energy conservation measures—particularly stringent ones in Japan—made up for much of the electricity shortfall.  The economies of both countries muddled through 2011; no economic calamity ensued.

However, renewable energy advocates were also shown to be off the mark.  Two years on, the sudden change from nuclear energy to other energy sources has gradually eroded both countries’ economic competitiveness through higher electricity prices.  As a result, Japan has begun to look to imported natural gas, shipped to the country as liquefied natural gas (LNG).  Japanese electric utilities now seek LNG sources for new gas-fired power plants.  But despite long-term LNG contracts, such plants do expose the country to natural gas price and currency fluctuations over time.  For example, the recent 10 percent decline in the Japanese yen vs. the U.S. dollar pushed up natural gas prices roughly the same amount because natural gas is priced in U.S. dollars.  Japanese industry has long worried about the impact of higher energy costs and has begun to lobby its government to restart idle nuclear power plants.  And with the Japanese economy trapped in multi-decade stagnation, Tokyo seems willing to try, not only to help Japanese industry, but also raise consumer consumption.

Similarly, electricity prices in Germany are now 15 percent higher than the average in the rest of the European Union.  German consumers already pay more for electricity than most other Europeans and have seen their electricity bills climb 40 percent over the last five years to pay for renewable energy subsidies.  Hence, some in Germany have come to wonder whether its Energiewende [energy transition] will lead to lower future economic growth as businesses—particularly those in energy intensive sectors such as machinery and steel—have shown signs of disinvesting in Germany and locating elsewhere.

Moreover, Germany’s shift to renewable energy sources has made the country’s electrical grid more difficult to manage.  The amount of electricity put on a gird must precisely match the amount that is consumed; otherwise variations in voltage could cause rolling blackouts.  Unfortunately, wind and solar energy sources can only generate electricity intermittently.  So even as these sources have become a larger part of Germany’s energy mix, the country’s electrical grid needs a way to smooth out their unpredictability.  That can only be done with conventional energy sources.  And since Germany is committed to phasing out its coal-fired power plants, it is now reconsidering the potential of fracking to fuel gas-fired power plants.

Thus, while it is possible to quickly change from one energy source to another without major mishap, the process cannot escape market fundamentals altogether.  Japan and Germany still need reliable and cost-effective energy sources to remain industrially competitive in the world.  Otherwise some industries will migrate to comparable countries, like the United States where fracking has contributed to a revival of American industrial production.  Renewable energy sources have demonstrated that they can meet a substantial share of modern electricity demands, but certainly not all or even the bulk of it—at least not until an innovator creates the better battery.

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